New York futures closed mixed this week, with the soon to expire December losing another 119 points to close at 58.54 cents/lb, while March gained 11 points to close at 58.86 cents/lb.

Liquidation of the December contract took center stage this week, as traders were busy getting out of positions ahead of tomorrow’s First Notice Day. Neither bulls nor bears seem to have any interest in getting involved in the December delivery, as open interest was already down to just 3’585 contracts (358’500 bales) before today’s session, during which another 3’750 contracts exchanged hands, reducing remaining bets even further.

With December closing today at 58.54 cents/lb, it is probably close to its fair market value. From a potential buyer’s perspective the current price probably works, but given the quality uncertainty, the lack of carry to March and the fact that bales taken up against December probably won’t make it on a boat before early January, it may not be worth the trouble. From a seller’s perspective deliveries would only make sense for some undesirable qualities, because the cost of bringing cotton to the board is prohibitive at the current price level. Not surprisingly there were no notices issued for tomorrow’s FND.

With the December notice period turning into a non-event, the focus is now squarely on March, which didn’t move much at all this week. The upside continues to be capped by the nearly 9 million bales of US cotton that remain unsold in a market that may have difficulty drumming up much interest, since its three main buyers China, Turkey and Mexico are expected to be a lot less active than usual during the remainder of this marketing year.

Although the market feels heavy, the unusually slow movement of the US crop into marketing channels has so far prevented values from caving in. When we look at the latest EWR (Electronic Warehouse Receipts) report and the weekly export shipments we have more than just anecdotal evidence that farmers continue to withhold cotton in an effort to maximize their loan deficiency payments.

As long as the AWP (Adjusted World Price) is trending lower week after week, growers will continue to hold back both their sold and unsold cotton in order to capture additional payment benefits. For our readers who are less familiar with the US loan program, a grower has the option to put his cotton into the government loan, for which he gets paid 52 cents, and he then has 9-10 months to buy his cotton back at the AWP (currently 46.12 cents) or at the loan plus carrying charges, whichever is cheaper. Another option is for the grower to forego the loan altogether and to get paid the difference between the loan and the AWP, which currently amounts to 588 points.

The AWP first dropped below the loan level in late September, or about the time when the US crop started to get harvested, and has trended lower ever since. AWP redemption values are always fixed for an entire week, from Friday to Thursday, and for the coming week the AWP is set at 46.12 cents, which is 245 points lower than in the previous week. That’s enough incentive for many growers and coops to hold on to their cotton a little longer. We need to clarify that not all growers will benefit from this loan game, as some of them may already have maxed out on payment limitations, especially if they have other crops like corn or soybeans that eat up their allowance. Nevertheless, there is still a substantial amount of smaller and medium sized growers, especially in Texas, who greatly benefit from these subsidies.

The daily EWR report shows that 6.4 million bales of US new crop are currently listed as ‘open’ and that only a little over 0.8 million bales are ‘under shipping order’ to domestic and foreign destinations. In other words, the cotton is there, but it is not being applied and shipped as fast as it should, which we attribute to the above-described situation. The US export sales report is another piece of evidence in that regard, as last week only 66’600 running bales got shipped. So far only 1.4 million statistical bales have been exported this season, which is over 600’000 bales less than a year ago.

US export sales on the other hand were quite decent in the last two reports, amounting to a combined 360’400 running bales of Upland and Pima cotton for both marketing years. Sales are not the problem, as total export commitments for the current season have already reached 6.6 million statistical bales or 66% of the expected total. This means that for the remainder of the season average weekly sales need to average only a little over 90’000 bales, which certainly seems feasible.

So where do we go from here? As long as the AWP keeps falling, it will be difficult to get enough US cotton into the system to alleviate the current bottleneck. Merchants are desperate to get their hands on cotton, especially for supplies they have already bought. The current AWP calculation of 45.86 points to yet another week of increasing subsidies, which would keep most cotton locked away. Sooner or later something will have to give, meaning that we need a spike in prices to motivate growers to finally let some of their cotton go. However, “flush-out rallies” would likely be sold into by the trade, since the newly released grower cotton would need to be hedged. We therefore see the market range bound in the foreseeable future, probably somewhere between 57 and 62 cents.